Tuesday, September 6, 2011

Public debt is too small

That's what Alex Izurieta says in his last paper (available here). He provides several important points to justify this view. First, once one excludes the debt owned by intra-government institutions the net debt-to-GDP ratio is around 60%. Not particularly large. Second, since 2009 government spending has faded away in its contribution to growth is turning negative, which means that in the absence of other sources of demand, the government is the only thing between us and a protracted recession. More importantly, since agents are in a "liquidation phase", that is still dealing with the consequences of falling assets prices on their balance sheets, then:

"to recover from a financial crisis, the ideal instrument is government support in the form of public debt, i e, government liabilities that are transferred to the balance sheets of private sector agents as their assets."

Not very likely to happen, but the reasons are not economic, and the solution is within the reach of reasonable, well-informed policy makers.